Q1 2026
The Short and the Long
Don’t believe the hype: Equity markets need Tech to perform
In late 2025, much (digital) ink was spilled over the fading of mega-cap Tech leadership amidst concerns around aggressive investment spend — and the subsequent impact on future earnings and cash flow.
But mega-cap Tech/ Comms still makes up 53% of S&P 500 2026 earnings growth, and around 40% of the index market cap. If you don’t believe mega-cap Tech can lead in 2026, then it is quite hard to be bullish on stocks.
Given the weight of these companies in U.S. equity indices, achieving meaningful index gains in 2026 requires some very heavy lifting from other sectors. Excluding the Tech and Communications sectors, the average sector return for the nine other S&P 500 sectors at 60% weight would need to be 16.7% to generate a 10% index return (roughly in line with consensus estimates for 2026).
That’s a heavy lift, and an outcome to which we assign a low probability. In fact, over the last 10 years, there have been zero instances of the S&P 500 up 10% y/y at month end with the Tech sector underperforming the aggregated other ten sectors.
While the Tech/ AI theme may experience near-term fatigue, fundamentals continue to favor the sector. We believe superior earnings growth and strong cash flow generation support Tech as a long-term core holding, even if rotation persists early in the year.
We continue to believe that technology investment will power the global economy and is essential for growth and profitability in every industry around the world.
The global economy exhibited resilience in 2025 despite material headwinds
Expansive U.S. tariffs disrupted global trade, increased supply chain complexity, and elevated uncertainty.
The World Bank’s Global Supply Chain Stress Index—which measures disrupted maritime container shipments—soared to an average of 1.8 million Twenty-Foot Equivalent (TEU) stalled containers in 2025.
This is not far below the peak of 2.2 million TEUs during the period of extreme supply-chain disruptions in early 2022 and compares to pre-pandemic levels of 0.3 million stalled containers (see Figure 1).
Business uncertainty was elevated in 2025, and inflation in most of the G7 remained at levels central banks traditionally view as inconsistent with their price stability objectives.
Thus, major economies remained in an environment in 2025 in which inflation continued to disrupt the decision-making of businesses and households.
Looking to early 2026, we see tailwinds for global economies
Some of which should become apparent in the first quarter, while others that will affect growth later in the year. First, aggregate global monetary policy is moving toward a more accommodative setting.
The inflation-adjusted policy rate for advanced economies fell from a recent peak of 1.8% in the third quarter of 2024 to 0.5% in the third quarter of 2025 (see Figure 2), declining further in fourth quarter given rate cuts by the Federal Reserve and Bank of England (only partially offset by the Bank of Japan’s rate hike).
Further easing in 2026 will be challenged by above-target inflation and resilient growth, while the Bank of Japan is expected to hike rates further in 2026.
However, since monetary policy affects the economy with a lag, the impact of lower policy rates delivered in 2025 will likely be felt in early 2026.
Key investment tenets for medium-term views
Valuations have little bearing on near-term forward returns
The notion of "buy low, sell high" is ingrained in money managers during the days of being an intern. However, we argue that this is difficult to execute in practice when investing for long-term wealth creation.
Many of the best-performing assets continuously trade at a premium valuation for years as they scale, grow, and compound into their previously lofty expectations that come to life through high multiples. Alternatively, assets perceived as “cheap” can remain at a discount for years due to broken business models and out-of- favor industries.
In fact, if an individual began investing 15 years ago in the three most discounted sectors of the S&P 500 at the start of every year just to "buy low," that investor would have underperformed the owner of the three highest multiple sectors nearly every year and by a cumulative 105% by the end of 2025.
Investing for "value" in discounted companies or sectors has not worked sustainably since before the Global Financial Crisis (see Figure 3).
Valuations "appear” elevated today because of index and bottom-up composition
Today, valuations at the top end of historic ranges are intimidating investors and keeping some on the sidelines.
With many media headlines trying to draw parallels to previous bubbles like the Dot Com Bubble in 2000, we can understand the hesitation. S&P 500 valuations (price to forward earnings) do remain in the top 5% of observations over the last 15 years — nearly two standard deviations above average — but there are stark differences to previous periods where valuations hit this point.
Profitability and compositional profile strength are two pillars of support differentiating today from these prior valuation highs. For example, net margins for the S&P 500 have also expanded to near-record highs as of December 31, 2025, showing a 0.74 correlation with P/E expansion over that 15-year period.
Simply put, companies are more profitable than ever, and market pricing appears to reflect today’s strong fundamentals (see Figure 4).
Risks on our radar
The early months of 2026 present a complex risk backdrop for investors, with markets balancing optimistic earnings expectations against both monetary and trade policy uncertainty. Consensus is largely bullish as we start this year, and we are watching several events that could shake confidence in current positions:
The Fed holds rates steady in 1Q given a backdrop of solid growth, stable labor market, and resilient inflation. Investors expecting additional rate cuts in early 2026 will be disappointed if higher front-end rates persist, even if for a good reason.
Why this matters:
- Rate-sensitive equities such as homebuilders, utilities, smaller-cap stocks, and unprofitable tech companies tend to rely more heavily on lower borrowing costs and may face pressure if front-end rates remain elevated.
- Fixed income markets that have priced in rapid rate cuts could experience near-term repricing, particularly for shorter-term bonds.
- More established companies with strong balance sheets, limited floating-rate debt, and pricing power may prove more resilient, while assets like gold may continue to benefit given its historically negative correlation to inflation.
Delays in data center construction become widespread, further debt-financing of AI investment stokes fears that it will soon stall out — or both. AI may be a generational opportunity for investment, and any deep cracks in the narrative present market risks in 2026.
Why this matters:
- AI-linked companies could face valuation and stock price pressure if spending timelines shift or returns take longer to materialize.
- Markets with lower technology exposure, as well as sectors outside of AI-intensive industries, may be less directly affected by these dynamics and may be beneficiaries of investors re-allocating their exposures.
- In periods of broader risk aversion tied to AI concerns, Treasuries and gold may once again play a stabilizing role in diversified portfolios as investors seek safe havens.
See our Short and Long quarterly report for more details